Verizon gets the iPhone tomorrow (probably), but who gets the profits?

Verizon (VZ) and Apple (AAPL) will hold a press conference tomorrow to announce, everybody on Earth and the inner planets believes, that Verizon will start selling the iPhone in February 2011.

The big question, though, is price. Will Verizon subsidize iPhone sales to the same degree that AT&T (T) does now? If so Verizon is looking at big sales in 2011 but a substantial ding to earnings. If not, Apple will either see its huge margins on the iPhone, estimated by some Wall Street analysts at 60%, reduced or Verizon will wind up selling the iPhone at a price that makes it much less competitive with phones based on Google’s (GOOG) Android operating system.

The answer to that question depends on which company, Apple or Verizon, turns out to have been most anxious.

Apple badly needs another selling outlet besides AT&T. That company’s network has been slowed by the huge amount of bandwidth iPhone users consume to the point that the slow speed of service has cut into iPhone sales. (And in some cities, the AT&T network has been inadequate, users like my New-York-City-based partner Bob say, from the beginning.) Add in price cuts from Android-based phone makers and Android-based phones that have closed the “coolness” gap with the iPhone, and it’s really not surprising that Android-based phones grabbed 26% of the smart phone market in November, according to ComScore MobiLens, to the iPhone’s 25%. (Android’s share is coming largely at the expense of Research in Motion’s Blackberry, which saw its share drop to 33.5% in November from 37.6% in October.)

But Verizon needs the iPhone perhaps even more than Apple needs Verizon. Every month that AT&T is the sole outlet for the iPhone means another month where Verizon adds fewer customers than its big rival. In the third quarter, according to All Things Digital, Verizon had fewer than 3 million smart phone activations while iPhone activations exceeded 5 million. Verizon is spending billions to upgrade its network and the company can’t afford to fall behind AT&T in market share.

I think Verizon was the more anxious of the two companies. And that the deal that will be announced tomorrow (probably) will show Verizon matching the big subsidies that AT&T pays Apple in order to keep the iPhone priced at $200 to $250. That will require Verizon to pay Apple a subsidy of $300 to $500 a phone.

When AT&T did its initial iPhone deal in 2008, those subsidies cost the company 11 cents a share in earnings in the first year of the deal. I’d expect something similar at Verizon in 2011.

The exact amount of the cut to earnings will depend on what kind of iPhone Verizon announces. A CDMA-only phone that runs on the company’s older network would have a potential, consultant PRTM estimates, market of 5 to 7 million users. A dual CDMA/LTE phone that took advantage of the new LTE-standard network (which operates at 10 times the speed of CDMA networks) that Verizon is now rolling out would have a potential market of 10 to 12 million users.

But the likelihood is that with LTE chipsets in short supply and Verizon still rolling out the LTE network (national rollout isn’t scheduled until 2013, Verizon says) the new Verizon iPhone will be CDMA-only.

That will have the effect of limiting Verizon’s 2011 and 2012 upside potential and the near-term hit to earnings. And it should remind investors that this is a deal worth investing in only if you’re patient enough to wait for the long run rewards in 2013 and beyond.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Apple as of the end of November. For a full list of the stocks in the fund as of the end of November see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/. I’ll have the fund’s portfolio as of the end of December posted in a few days.